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1980 Top in Gold as a Reference Point for Precious Metals Investors

By: Przemyslaw Radomski | Thursday, December 27, 2012

This essay is inspired by a question we received from one of our subscribers.
On December 2012, we published an essay on gold
and the dollar collapse in which we pointed out why you might profit from
gold even if the U.S. dollar doesn't deteriorate completely. Today, we will
elaborate on why we actually use the 1980 top in comparisons.

The fact that nobody really knows with absolute certainty where gold will
really go from today onward makes people try to make their own guesses about
what can happen with the yellow metal. One of the methods to do that is to
look back into past situations and try to estimate if what is happening now
is somehow similar to those past events.

In fact, history doesn't repeat itself precisely. What happened once doesn't
come back in exactly the same way. Because of that the future is not something
that is completely predictable and those who aim to predict it (for instance analysts and investment
tools). But what happens now can be similar to what has happened before.
J.R. Colombo wrote "'History never repeats itself but it rhymes,' said Mark
Twain". It may be possible that some patterns repeat
themselves. The same goes for everything that's happening with gold. And even
if past patterns don't give you any certainty, sometimes they can limit the
uncertainty.

The situation in the gold market today is different than that one in 1980
in a few important areas. Let us analyze that in more detail. The chart below
presents U.S. inflation figures.

The red line represents official inflation data
as published by the Bureau of Labor Statistics. The gold line represents the
inflation data calculated according to the methodology used in 1980. There
is visible divergence between the two lines after 1980, and particularly after
1985.

Let's focus on the 1977-80 period. The annual inflation rate went up from
5.2% in January 1977 to 14.8% in March 1980. This rise was partially due to
the deteriorating political situation in Iran, one of the OPEC nations. In
early 1979, Iran saw a revolution which resulted in political power being
shifted from the Shah of Iran to a religious leader, Ruhollah Khomeini. In
the wake of the revolution, oil exports fell, curtailing global supply and
driving prices of oil higher which, in turn, fueled the rise in prices of
many other goods.

This is, however, only part of the story. OPEC countries increased oil supply
to compensate for shortages but the oil crisis was exacerbated by an embargo
on Iranian oil imposed by U.S. President Jimmy Carter following an incident
in the U.S. Embassy in Teheran, where more than 60 U.S. citizens had been
taken hostages. With the embargo in place and public panic about the availability
of oil, buyers rushed to acquire oil while they could. Increased demand caused
even further increases in prices, and so the cycle continued. This is quite
important as it shows that the effects of adverse events can be worsened by
crowd behavior.

From January 4, 1977 to January 21, 1980 the price of gold rose from $135.70
to $850 (526.4%), partially fueled by soaring inflation. Let's take a closer
look at this bull market.

It is particularly worth noting that even though the bull market had started
long before 1980, most significant appreciation (in dollar terms) occurred
in December 1979 and January 1980 when prices went up from $428.25 (December
3, 1979) to $850 (January 21, 1980). In percentage terms, this last period
is slightly less spectacular, but the point here is that the very end of the
bull market saw the most significant appreciation in the yellow metal and
that the price of gold followed a path of "exponential" growth during
this period.

This period of exponential growth was partially triggered by the fact that
on December 24, 1979 the Soviet army invaded Afghanistan starting what would
escalate to a 10-year-long war. This event, combined with the abovementioned
second oil crisis and soaring inflation in the U.S., sent commodity prices
sky high. But, once again, this is not the whole story. Namely, inflation
and the Soviet war in Afghanistan were decisive in triggering the final rally,
but it were emotional reasons that made investors and speculators rush
for gold and amplified the price moves.

It is also worth noting that, once the panic about inflation and the war in
Afghanistan was over, gold retraced back to as low as $485.25 as soon as on
March 27, 1980. So the craze started in December the previous year and lasted
for only about four months. And this relatively short period seems to be defining
how people perceive the 1980 bull market now.

Now, let's make a quick comparison between 1980 and the current bull market.
Back in 1980 official inflation numbers were two-digit, while today they stand
at approximately 0% (official data) or 4-10% (inflation calculated according
to methodologies which were in place in 1980 or 1990). In 1980 the scare of
the Soviet war in Afghanistan was an important factor. Today, the situation
in Iraq has been getting less and less attention, particularly since the U.S.
withdrew its military personnel from the country in December 2011.

So, there doesn't seem to be a war in the equation, and the current economic
environment is deflationary rather than inflationary (official figures). On
the other hand, alternative inflation figures suggest that that environment
is not as deflationary as one might think. But, all in all, the situation
today is in fact very different than it was in 1980. So why do we even use
the 1980 top in comparisons?

First of all, even though we don't see inflation eating away at our pockets
doesn't necessarily imply that there uncertainty about the economy is limited.
Right now, with unemployment at 7.7% and with a debt pile larger
than GDP and growing, the U.S. economy doesn't look deprived of uncertainty.
To pay off such amounts of debt the economy either needs to start growing
or the government can inflate the debt away. So, even though the inflation
as seen in 1980 is definitely not here, it is at least possible (and in our
opinion - likely) that it will materialize in the future.

Secondly, if the economic situation suddenly deteriorates, we could experience
effects similar to the ones seen in 1980 because of the Soviet war in Afghanistan
(unlikely but possible). Even if financial turmoil brought gold temporarily
lower as in 2008, it seems conceivable that such an event would be followed
by strong appreciation of both gold and silver.

Finally, and probably most importantly, even if we don't see considerable
inflation or the deterioration of the dollar, we still seem to be in a long-term
bull market. This bull market can continue to unfold as in the last decade,
quite differently than the 1977-80 appreciation in gold but human emotions
haven't changed that much since 1980. So, in the third phase of the bull
market, when everybody would want to own gold, we might see a similar "exponential" price
growth pattern. Actually, the events could play out a lot quicker than they
did in 1980.

The 1980 serves as a reference point but right now the audience that might
want to take interest in precious metals is a lot broader than it was back
in 1980. As we pointed out in our essay on gold
and the dollar collapse, right now there is no Iron Curtain to prevent
people from Central and Eastern Europe to take part in the bull market. China
and India are developing and investors from these countries may fuel the bull
market as well. You can read more on that topic in our report on gold
in India. What is more, right now it's a lot easier to manage your money
than in was in 1980. Taking or reversing your positions in gold is a matter
of seconds and minutes and not hours or days. Because of that, it is possible
for any rally in the end stage of the bull market to be even more pronounced
than it was in 1980.

To sum up, we use the 1980 top for comparisons not because the current
economic situation is very similar to the one in 1979-80. In fact, it's very
different in some crucial areas, but the key point is the same - the fundamental
situation was positive for gold in 1970s and it is the case right now. We
use because it seems that human nature and emotionality hasn't really changed
since 1980. We still can see a period of "crazy buying" at the end of the
bull market. What has changed, though, is the number of people that can participate
in the bull market and the technological infrastructure. Because of that,
the 1980 top can only be used as a general reference point and not as a precise
target. The changes in the markets may make the final rally of this bull market
significantly more volatile than it was in 1980.

Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who
takes advantage of the emotionality on the markets, and invites you to do
the same.

His company, Sunshine Profits, publishes analytical software that anyone can
use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem
that may never be solved, PR has changed the world of trading and investing
by enabling individuals to get easy access to the level of analysis that
was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are
results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals
sector. For that reason it is his main point of interest to help you make
the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for
professional excellence and ethics for the ultimate benefit of society.

Disclaimer: All essays, research and information found above represent
analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates
only. As such, it may prove wrong and be a subject to change without notice.
Opinions and analyses were based on data available to authors of respective
essays at the time of writing. Although the information provided above is
based on careful research and sources that are believed to be accurate, Przemyslaw
Radomski, CFA and his associates do not guarantee the accuracy or thoroughness
of the data or information reported. The opinions published above are neither
an offer nor a recommendation to purchase or sell any securities. Mr. Radomski
is not a Registered Securities Advisor. By reading Przemyslaw Radomski's,
CFA reports you fully agree that he will not be held responsible or liable
for any decisions you make regarding any information provided in these reports.
Investing, trading and speculation in any financial markets may involve high
risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates
as well as members of their families may have a short or long position in
any securities, including those mentioned in any of the reports or essays,
and may make additional purchases and/or sales of those securities without
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